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Guarding against “Greenwashing”: the Governance conundrum

For financial professionals only

As ESG investing has grown in popularity, we’re increasingly seeing two things happen:

  1. more advisers questioning how we identify genuinely “ethical” funds for our Ethical solution
  2. more details being included in our fund information packs on how ESG feeds into the fund manager’s investment process

Cynics among you might think that more details (point 2) lead to more questions (point 1). But that isn’t necessarily the case.

Take fund selection in our “lightest green” ethical mandate, Profile A. The focus of this profile is responsible investing, demonstrated by responsible behaviours in the underlying businesses and our selected fund managers acting as good corporate citizens.

It’s a people thing

Good governance might be topical now because it’s the G in ESG, but in reality, identifying well-managed companies has long been a tool used by active managers.

It’s just like you, as an adviser, wanting to speak to our investment team from time to time. We too have an open and regular dialogue with the managers of the funds we own. Similarly, the fund managers will have an ongoing relationship with the senior management of the companies they buy.

It’s partly about accountability, and partly about confidence. We want to understand our fund managers’ decisions. We want to see how they react if they are challenged. The words and body language they use inform our conviction in them, above and beyond what the numbers might tell us.

Inputs versus outputs

Good businesses, managed prudently, do well.[1]

Fund managers wanting to beat the benchmark are looking for businesses that will outperform, so it’s no surprise they pay special attention to management behaviour and strategy.

Likewise, as fund pickers, we’re looking for the best active managers. So it’s no surprise we end up talking to those who have used governance as a filter to identify good companies – those that they believe will grow and be profitable, hopefully with lower risk along the way.

In this way, governance is effectively an input into the investment process, where the fund’s objective is to deliver strong long-term returns.

Where we get really interested in a fund for our Ethical Profiles is when governance isn’t only an input, but an output too. This means that, as well as being an effective filter in the process, it also helps to drive more positive behaviour, alongside the investment outcome.

Getting engaged

This is known as engagement, and it’s where fund managers use their influence as major shareholders to encourage best practice.

This could be through:

  1. Ongoing communication around policy and conduct – take the case of Stewart Investors who’ve long engaged with Indian business GCPL on plastic pollution. Through these efforts, GCPL have committed to sustainable packaging and targets, published online. Further, to help the organisation achieve their targets, Stewart pro-actively introduced them to a UK-based biodegradable plastics company[2].
  2. Exercising voting rights – this is a key tool for equity managers that comes with share ownership. Across our funds we understand that excessive executive remuneration has been a particular area voted against in recent years.
  3. Divestment (or threat of) – for example, Edentree removed Centrica from their portfolios over concerns that the company’s timeline for ceasing oil exploration and production was too long, too uncertain, and incompatible with the firms stated ambitions to support a low-carbon future.[3]

Separating the wheat from the chaff

When we’re looking at a fund for inclusion in Profile A, we look for compelling risk adjusted returns as we would with any fund. We are also likely to see governance mentioned as a factor considered in the investment process. But that alone is not enough.

With the help of our independent Ethical Oversight Committee, we also assess the fund management company. We look at their membership of ESG-related bodies, for example whether they have committed to the UK Stewardship Code or are signatories of the UN Principles for Responsible Investment, and their voting history. We read their responsible investment reports, and in our ongoing due diligence, we dig deeper into how they engage with businesses and ask for specific examples.

This is how we protect our “lighter green” investment solution from “greenwashing”. This is how we distinguish between a responsibly managed fund and a Responsible one – with a capital R.

[1] ESG Investing: A Social Uprising, September 2018, hermes-investment.com

[2] 2019 Responsible Investment & Stewardship Report, firstsentierinvestors.com

[3] EdenTree Responsible Investment Activity Report 2019, edentreeim.com